How far can growth theories take us in poverty reduction efforts?

1. How far can growth theories take us in poverty reduction efforts? This class is in two parts: • Caution about the seemingly strong and positive correlation between income per capita, health, and education • Derive policy implications for economic development and poverty alleviation from two well-known models of economic growth

2. 1. We argued in the last class that income per capita level was linked to: • Health • Education Then: If poor countries grow very fast so as to catch - up with the income per capita levels of the rich countries, health and education in poor countries should improve. WDR (2004): No, for at least three reasons: a) Affordable access to health and education is low – especially for poor people b) The quality of health and education is low, and…..

3. c) Growth alone is not enough for achieving the MDGs

4. But no-one can deny that the “growth” component is important Which brings us to the second part of this class…..

5. 2. Two growth models and their implications for our subject matter a) The Harrod – Domar (H-D) model Named after articles by Roy Harrod (1939) & Evsey Domar ( 1946) Bottom line: What drives economic growth is investment

6. H-D in a nutshell Savings translate into investment, in turn the engine of growth Y(t) = C(t) + S (t) S (t) = I (t) Y(t) = C(t) + I (t) Now, assume depreciation K(t+1) = (1 – δ)K(t) + I (t), and Let: θ = K (t)/Y(t), s = S(t)/Y(t) and with some computation: s/ θ = g + δ which is the well-known H – D equation

7. Example s = 6 , θ = 3, δ = 0 gives a g = 2 suppose the country wants to grow at 7 needs s = 21 saving needs – savings that the country can generate = savings gap 21 – 6 = 15 can be “filled” via foreign aid or foreign direct investment (FDI) Is this true? Please do not forget to read *Easterly for next Monday….

8. Drawbacks • Savings: a necessary but not a sufficient condition • Both s and θ are exogenous • Population growth is not in the picture To account for this, DR introduces the notion of demographictransition, and uses this concept for amending the H-D model → in turn generating a “poverty trap”

9. Adding population growth to the H-D model (DR, pp. 60 – 61) Population growth rate g Threshold Trap Per capita income

10. b) The Solow Model Named after Robert Solow’s (1956) famous article The Solow model in a nutshell: Income is generated with a combination of capital and labor, and, increasing capital per unit of labor is subject to diminishing returns Changes in capital per unit of labor can change income per capita transitorily But in the long-run income per capita growth is zero unless there is exogenous technological progress So, the main engine of economic growth of income per capita is exogenoustechnological progress

11. The standard Solow diagram y (δ +n)k sf(k) K* k k

12. The Solow diagram with technical progress ŷ (δ +n+g)k sf(k) Capital per efficient unit of labor

13. First Prediction Relevant To Poor Countries High savings and investment → High level of income

14. Second Prediction: High population growth will lower the level of income per head

15. Third Prediction: Poor countries will grow faster relative to rich countries→ convergence

16. Next class:1) * Easterly, William (2002), Chapters 1 -3 (Lamont library has it)2) Carlin, Wendy, and David Soskice (2006), Macroeconomics, Imperfections, Institutions, and Policies, Oxford University Press., Chapter 14